Daily Newsletter, Wednesday, 2/15/2012

Table of Contents

Market Wrap

Apple's Big Move and A Review of the Stock

by Keene Little

As stated in tonight's teaser paragraph, Apple has been the driver of this rally and today's gap up and rally to a new high had a lot of excitement around it. But it tagged an important Fibonacci projection and sold off hard, creating a key reversal day. We'll look at a thorough review of the stock, and its meaning for the market tonight.

Market Stats

The day started with a gap up but not as larger as it was looking with last night's futures. Following the rumor-inspired 30-minute rally into the close on Tuesday (funny how those rumors arrive just before the market closes but negative news/rumors always get released after the market closes), there was another +10-point move by the S&P futures as more "good" news came out of Greece about an agreement to sign an agreement that nobody really knows what it means since many EU ministers and private investors still need to agree upon. But some of that overnight excitement waned before the U.S. markets opened and there was a struggle to keep the markets up into about mid day. The afternoon then sold off and there was only a small bounce into the close.

The morning's economic reports were not market moving. The Empire Manufacturing index was a good report, improving from 13.5 to 19.5, which was better than the 14.8 that had been expected. But Industrial Production came in at 0% vs. December's +1.0% and Capacity Utilization stayed virtually the same at 78.5%. The NAHB Housing Market index improved from 25 to 29, the best showing since May 2007, and home builder sentiment is improving. Does that mean they'll build more inventory that the market doesn't need? So it was a bit of a mixed bag and that's why the market pretty much ignored the reports. It had much bigger things to think about, such as Greece (so what else is new).

Europe's economy has stagnated but I suppose the good news is that it hasn't "officially" dropped into a recession (yet). Their GDP dropped -0.3% in the 4th quarter, giving back the small gains of +0.2% and +0.1% in the 2nd and 3rd quarters, respectively. The trend though is clearly not in the right direction.

But as far as the debt levels by the European nations, never fear for China is here. They assured Europe that they would continue to invest in its debt and that gave Europe a little boost on the news, with their major indexes finishing flat to slightly positive for the day. The rally was thwarted on the news that the decision on the second Greek bailout will be delayed until the Brussels meeting on February 20th.

In the afternoon the FOMC minutes for last month were released and the market was disappointed to read that there were only a few members who believed another round of QE and bond purchases was warranted. The market realizes QE3 is probably not going to be announced at the next meeting.

Sentiment is key for this market and since last October there's been a lot of hope that the problems in Europe will be solved (no defaults), that the central banks will continue to pump money into the financial system like there's no tomorrow and that the earnings growth would return to what they were like before last year. Hope is a wonderful thing and optimism is what moves the human race forward, knocking down obstacles in our path. Problems become opportunities. But in the stock market hope is a 4-letter word and rallies built on hope without substance tend to leave big air pockets below.

I mentioned last week that bullish sentiment vs. bearish sentiment is hitting the same extreme levels that we've seen at previous market highs. It's simply a warning sign but an important one. Another indication of bullish sentiment, and a willingness to get into the riskier trades, is to look at the amount of volume going into the tech stocks vs. the broader indexes such as the NYSE. The theory here is that bullishness hits an extreme at market highs and that bullishness is reflected in buying the sexy, and riskier, tech stocks (looking for growth instead of dividends). Bullish frothiness (that's a technical term) in the techs tends to mark the blow-off phase of a rally.

The chart below shows the NYSE price at the top and a ratio of volume going into the tech stocks vs. the NYSE. I've drawn a horizontal line at about 2.7 and called it the trigger line. When the ratio reaches or exceeds this line we should be looking for a top in the market. I've drawn vertical lines at these ratio peaks and you can see it does a pretty good job at telling you when you should at least button up your stops on long positions. At the moment we have another one of those signal, with the last one being last October (in fact we have a little double signal from last week and this week, which is perhaps a double warning).

NYSE price vs. the volume in techs related to volume in NYSE

Another sign of bullishness can be measured using the RYDEX bull and bear funds. Retail traders tend to use these funds based on what they're hearing from the media, friends and family. We all know the retail crowd tends to join a trend late in the game and are wrong at the turns. At the moment there is an 80:1 ratio of the amount invested in bull funds vs. bear funds, an extreme never seen before. People are more bullish about the stock market now than they were at previous market highs. This is very typical in a correction and it's what leads to a stronger decline for the 3rd wave down. It will likely be stronger than the decline in 2011 and perhaps stronger than what we saw in 2008.

The front cover of Barron's over the weekend had a big headline declaring "DOW 15,000" in two years and said DOW 17,000 is a 50-50 bet. It's a well-known fact that headlines like this in major non-financial publications tend to come right at the end of the trend. By the time the trend is recognized and put into the magazine production schedule and then printed the trend is well established and close to finishing.

One reason the author cites for the bullishness, which was derived from the work a researcher had done, was the increasing number of corporate stock buybacks. As the author states, "Stock buybacks contribute to total returns by putting upward pressure on stock prices." This is like saying stocks can only head higher because there's so much money sitting on the sidelines (I just heard that argument again over the weekend). But what are the real facts with these stock buybacks and their timing in the market? A picture is worth a 1000 words:

Stock Buybacks and Market Timing, chart courtesy elliottwave.com

It turns out corporations are probably one of the worst at market timing. They pay top dollar to buy the majority of their shares back and then sell when the prices are at their lows. It's a good thing corporate profits are not dependent on the trading of their own stock but you can imagine the huge waste of money when they buy back their shares instead of investing in something else (or let it sit in cash). The bullish assumption that was made in the Barron's article is flat out wrong and yet many will read it and accept it as fact.

An interesting side note is that corporate insider selling is hitting highs not seen in a while. While insider selling vs. buying is hitting new highs they have their companies buying back its stock. The insiders are apparently more interested in selling their personal stock to the corporation, believing the values are about as good as they (personally) are going to get.

Before moving to the regular charts I want to focus a little on Apple (AAPL) tonight because I think it's instructive what's happening in it and the tech stocks in general. It's a very good gauge of market sentiment.

AAPL has been the recipient of much of the bullishness as it has now gone parabolic in its climb from November. Like moths attracted to a flame (and I use that analogy purposely), traders are chasing this hot stock as the excitement reaches a fever pitch. The stock market is one of the few places where people are happy to pay higher prices (with the belief that it will keep going higher) and as AAPL has rallied we've seen a huge influence on the tech indexes and the market in general. It could be simply the favorite stock of momentum players right now but as a sentiment gauge this is a good stock to keep an eye on.

As shown on the chart below, AAPL's rally has gone parabolic, which is actually not a good sign for the stock. It's being chased by momentum players and when they're finished and start exiting en masse we're going to see a fast drop back down. You'll then see the HFTs (high frequency traders) jump on the short side and slam it back to earth. True AAPL believers in the company (who will hold the stock all the way back down) will stare in wonderment how people just don't get what a great company it is. Keep in mind we're talking about the stock price, not the company. Those who fall in love with the company forget to protect profits in the stock.

All parabolic moves end exactly the same way -- a crash back down and most often a return to the start of the parabolic move. For this case I'm showing the start of the move from November, near 360, but in fact a larger move would mean a return to the January 2009 low (near 80). I think a return to 360 is certainly reasonable to expect.

Apple Inc., AAPL, 480-min chart (parabolic move)

Todd Harrison showed a chart yesterday at Minyanville of previous bubbles and their collapses since the tech dot.bomb following the 2000 high (someone needs to tell him black backgrounds are not good for showing charts). It's hard to read but the green spike back into the 2000 high was the COMPQ. That was followed by the Shanghai Composite (yellow) into its 2007 high and then commodities (oil shown in white) shortly thereafter in 2008. You can easily see what happened after each of those parabolic spikes. The last spike (orange) is AAPL. Will it end differently this time? Anything is possible. It's also possible it will return to the low in January 2009 (78) or perhaps to the highs near 200 in 2007/2008. I know, not to worry, it's not the same for AAPL which is such a leading tech company, has great products and management, blah, blah, blah. I heard exactly the same thing when the semiconductor market peaked in 2000 (and I was a big believer in it since that was my background) and when oil peaked in 2008 near 147 before it crashed back down to 33 in six months. And then after the fact there will always be explanations for why it happened.

Parabolic rallies since 2000, chart courtesy Minyanville.com

Relating to tech earnings, I saw an interesting chart at zerohedge.com last week which shows the huge impact from AAPL vs. the rest of the stocks, as shown below. In fact the trend of earnings for the rest of the tech stocks since the beginning of 2011 is not good, and the earnings in the 4th quarter were especially weak. I need to be reminded again why it's a great time to be buying this market. Everyone on CNBC tells me so and surely I can believe them. Right?

Earnings with and without AAPL, chart courtesy zerohedge.com

This big push in AAPL has some speculating that money has been pouring into the stock as a way to help hold the major indexes up (to keep the public bullish) while big money offloads their inventory to the retail crowd (which includes many mutual fund managers). This idea of pumping up AAPL is of course just speculation but we also are hearing big money managers telling the public this is a great time to buy. All of this has me feeling a little suspicious about what's going on.

The big-picture look at AAPL, with its monthly, weekly and daily charts, shows why I'm so interested in trying to identify a high for the stock (and hopefully help you protect profits if you own the stock and have been planning on owning it for the long term). The move up from 1997 can be counted as a 5-wave move and once it completes we'll see a correction of that move. The only question is how much it will correct. I mentioned earlier that a correction to at least 360 (the November low) would be reasonable. On the monthly chart that kind of pullback would be puny and it's not at all unreasonable to expect a pullback to its previous 4th wave, which is the January 2009 low (78), over the next 12-24 months. I have no idea what it will do; I merely present the picture of risk.

AAPL monthly chart, log price scale

Focusing on the 5th wave, which is the move up from January 2009, it too can be counted now as a 5-wave move. Again, pulling back to only 360 (the previous 4th of the 5th wave) seems like it would be a very small correction of the rally from 2009. It could certainly be a lot more and I'm showing just one possibility for the coming year (dropping below 300). Even a pullback to its 200-week MA would mean the stock price will get cut in half. The week's candle, so far, is a shooting star at trendline resistance (actually a more bearish gravestone doji at the moment). A drop back below the upper trend line, near 500, leaves a throw-over finish to its rally. It's common for to see a little throw-over above the top of a rising wedge pattern so we'll have to see how the week closes.

AAPL weekly chart, log price scale

The current daily chart of AAPL shows an interesting setup at the moment, pointed out earlier in the day, which is based on a Fibonacci projection that was achieved this morning. The chart is now focusing on the final 5th of the 5th wave, which is the move up from November and it needs to be a 5-wave move (the fractal nature of EW). In an extended move to a high, it's common for the 5th wave to achieve equality with the 1st through 3rd waves. In a really extended move, such as a blow-off top (which AAPL qualifies for), the 5th wave will become 162% of the 1st through 3rd waves and for AAPL that projection is at 523.80. Today's high was 526.29 and it was followed by a mini-crash off that high. So, will that be it? Only time will tell but it makes for an interesting setup here. If AAPL and the SOX start to tuck tail and turn down it's going to be a big negative factor for the tech indexes and broader market.

AAPL daily chart, log price scale

AAPL closed below 500 today and in so doing it closed back below the trend line across the highs from March 2000 and December 2007. This followed a test of the trend line along the highs from April 2010 and it left a throw-over finish above the top of its rising wedge. It also created an outside down day -- gap up, make a new high, close below the previous day (in this case it engulfed the previous two days). It's a key reversal candlestick and needs no confirmation from the following day's candle -- it was a sound rejection of the rally attempt. Assuming today's high was the completion of the rally, the only question now is what kind of pullback we're going to see. Protect thyself.

And with that let's move to the regular charts covered here. The SPX weekly chart shows a possible rising wedge as well. I think the greater risk is for an important high now rather than later and therefore I'm showing a strong decline to follow. But I also recognize we might get just a pullback into next week and then another final rally leg higher into March, which has been a very important turn month since 2000. Evidence of which it will likely be will come from the kind of pullback pattern we get (choppy vs. impulsive).

S&P 500, SPX, Weekly chart

The daily chart shows a smaller rising wedge pattern for the rally from December, with the bearish divergence accompanying the rally. The uptrend line from December 19th was broken yesterday but saved by the rumor-inspired rally in the final 30 minutes. Sitting near 1348, it was broken again today, which should be a good indication we're into at least a larger pullback correction. The challenge here is that it doesn't look like a clean finish to the upside (from an EW perspective) but I've long ago recognized that the short-term wave counts are getting really messed up by the massive manipulation going on in the market today. So the trendline break is the first bearish clue.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1355
- bearish below 1300

The DOW's daily chart below shows how much it has struggled against its May high at 12876. At the same location is its longer-term broken uptrend line from July 2009 through the August 2011 low, which is the line that stopped the October rally. Two equal legs up for the 3-wave bounce off the October low is near 12912. The combination of these three things has created a very strong line of resistance near 12900. Today it dropped down and tested its 20-dma near 12764, which held. A break of this support would be the first warning that intermediate-term fund managers will pay attention to. Notice the break of the uptrend line on RSI -- a warning the leg up from November has finished (or we could get one more minor new high with bearish divergence on RSI).

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 12,900
- bearish below 12,500

The uptrend line from December 19th was broken last Friday, recovered marginally on Monday, broke again on Tuesday, tested this morning and then sold off again. The bearish wave count calls the choppy price action since last week's high the start to a larger decline. Today's decline was a 5-wave move and as such we should see at least a bounce Thursday morning to correct the decline before heading lower again in a stronger selloff. The bullish wave count calls today's decline the completion of an a-b-c pullback from Monday, which will be followed by another rally leg into next week (it could end up being a very choppy rally that works its way higher to 13K before starting a larger selloff).

Dow Industrials, INDU, 60-min chart

Just like AAPL, NDX formed a bearish engulfing candlestick today and created a key reversal day in the process. It gapped up, rallied up to the top of a parallel up-channel from December and then closed below the previous two days. I'd be very surprised to see make a new high this week (I hesitate to say that because of all the manipulation in this market but the technical pattern tells me we should be looking down into Friday, not up). Only in time will we have a better sense as to whether we'll get just a pullback and then another rally into March but a break below the July 2011 high near 2438 would be the first bearish heads up that no new highs are coming.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 2600
- bearish below 2438

The RUT has been the weaker index, which has been a canary in the bull's coal mine and today's break of its uptrend line from November is a bearish warning. Its 20-dma is marginally lower, near 809 on Thursday, so watch for a possible bounce off of that and resistance at its broken uptrend line.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 834
- bearish below 770

There's not much of a change from last Wednesday as far as what I have to say about the banks. BKX pushed marginally higher on Thursday before closing back below Wednesday's high. It has rolled from resistance after completing a 5-wave move up from November, which completes an A-B-C bounce off the October low and should now be followed by another decline that takes it below the October low. There's very little doubt in my mind about this one.

KBW Bank index, BKX, Daily chart

While the EW count for the TRAN is subject to interpretation, for the short term the break of its uptrend line from October is bearish. Note the breaks of the uptrend lines on RSI, confirming price weakness and probable high of importance.

Transportation Index, TRAN, Daily chart

The dollar looks to be struggling every day but then pushes up higher. I think if it can through a band of resistance at 79.65-79.95, so above 80, it will have clear sailing higher. Until then there remains the potential for a drop back down to the bottom of its up-channel from August, near 77.50 at the end of this month.

U.S. Dollar contract, DX, Daily chart

Gold's short-term pattern, since the high at the beginning of the month, leaves me guessing what's next. If the stock market sells off (and the dollar rallies), gold will very likely drop lower. It has several support levels between here and about 1660, so about 70 point. It could try for another test of its broken uptrend line from October 2008, near 1800 by the end of the month. Silver has a very similar pattern and could also go either way from here over the next week or two.

Gold continuous contract, GC, Daily chart

Oil looks bullish at the moment and following up on last Wednesday's projection, I think the upside target at 106.65, for two equal legs up from December, has a good chance of happening. That could then complete the bounce pattern off its August low and lead to another decline. A drop below last Friday's low near 97.30 would turn me more bearish sooner rather than later.

Oil continuous contract, CL, Daily chart

As you can see in the chart below, it's looking like the reports will not be showing much of a change, if any, from last month (or week for unemployment claims). Once again, I don't think the market is paying much attention to these reports anyway. It's what's happening in Europe that has everyone's attention.

Economic reports, summary and Key Trading Levels

If we go with AAPL's and the tech indexes' charts tonight, we saw key reversals for the stock market. We could get a little bounce Thursday morning to correct this afternoon's decline but I would look at it as a shorting opportunity. If the market gaps down instead then it will obviously be more immediately bearish, especially since it could be the result of some disappointing news from Europe and probably about Greece.

Keep in mind it's opex week and one more day before European-style options stop trading (they settle Friday morning) and there could be an "effort" to save institutions and their short put positions. The flip side of that is any hedging or covering of bullish positions merely creates more selling pressure, which is why selling during opex week can become exacerbated by options squaring. It's likely to be either a wild day or a very quiet and dull day. Friday will likely be quiet if it's a normal opex Friday. But if the market is at the beginning of an important turn we could see some volatility pick up.

Speaking of volatility, the VIX pushed up to the top of its constricting Bollinger Band on Monday, pulled back to the center of it (20-dma) on Tuesday and is now pushing back through the top of the band. The constriction in the BB calls for an explosive move in the VIX from here. My guess is that the move will be to the upside and that would be bearish for the stock market.

The pieces of the puzzle are in place for the bears, almost handed to them on a silver platter here. Only they can decide whether or not they'll take advantage of the setup. But even if the bears don't join in the selling (fearful of another spike back up at any time), we've got a lot of traders who have already bought into the idea that the market is heading higher. That means we have a market full of sellers and very few buyers left.

Good luck for the rest of this week, trade carefully and I'll be back with you next Wednesday.

Keene H. Little, CMT

In the end everything works out and if it doesn't work out, it is not the end. Old Indian Saying

Why We Like It:
Shares of this technology company appear to have hit a bottom. The stock was crushed in early January on an earnings warning but shares have since recovered significantly. Now APKT is breaking through multiple layers of resistance. Today's show of relative strength is a bullish breakout past the simple 100-dma. Helping fuel gains are relatively consistent rumors that APKT is a takeover target.

I am suggesting a trigger to open small bullish positions at $36.05 with a stop loss at $33.65, which is under the 10-dma. The $40.00 level has been resistance in the past so we'll set our exit target at $39.75.
FYI: The Point & Figure chart for APKT is bullish with a long-term $54.00 target.

Trigger @ $36.05 (small positions)

Suggested Position: buy APKT stock @ (trigger)

- or -

buy the Mar $35 call (APKT1217C35) current ask $2.55

Annotated chart:

Weekly chart:

Entry on February xx at $ xx.xx
Earnings Date 04/26/12 (unconfirmed)
Average Daily Volume = 4.1 million
Listed on February 15, 2011

Comments:
02/15 update:
It looks like our ADM trade is getting off on the wrong foot. The trade was opened this morning as both ADM and the S&P 500 opened positive. ADM rallied to new multi-month highs at $31.54 only to reverse and close lower on the session. Today's intraday move looks like a potential short-term top.

I am not suggesting new positions at this time. We can look for short-term support near $30.50 and reconsider new positions there.

Earlier Comments:
More conservative traders might want to consider waiting to buy a dip near ADM's rising 10-dma. FYI: The Point & Figure chart for ADM is bullish with a $40.00 target.

current Position: Long ADM stock @ $31.21

- or -

Long Mar $32 call (ADM1217C32) Entry $0.47

Entry on February 15 at $31.21
Earnings Date 05/03/12 (unconfirmed)
Average Daily Volume = 5.6 million
Listed on February 14, 2011

Comments:
02/15 update:
The stock market's major indices hit some profit taking today and look like they could trade lower tomorrow. More conservative traders may want to exit our ADSK trade early to lock in gains. Please note that I am raising our stop loss to $36.95.
I am not suggesting new positions at this time.

Comments:
02/15 update:
DFS rallied to new highs thanks to positive credit card trends. The company's net charge offs (uncollectable debt) in January fell to 2.75% down from 3.15% in December. A year ago these were at -5.75%. The number of customers that were behind on their payments fell to -2.31% down from 2.32% in December.

The stock shot higher to $29.35 intraday but pared its gains thanks to the market's weakness. I am raising our stop loss up to $27.75.

Comments:
02/15 update:
The stock market's lack of progress today left DRIV churning sideways. We are still waiting for a breakout from this trading range.

DRIV can definitely see some volatility so we want to keep our position size small to limit our risk. I am suggesting bullish positions if DRIV can trade at $18.50 or higher. There potential price resistance at $20.00. There is potential technical resistance at the 150-dma and exponential 200-dma (see chart below).

Comments:
02/15 update:
Uh-oh! ETN underperformed the market today with a -1.6% decline and a close under its simple 10-dma. The stock should find support near the $50.00 level but I am not suggesting new positions at this time.

Comments:
02/15 update:
It looks like JOSB's rally may have temporarily run out of gas. The stock rallied to 452.39 this morning before turning lower and posting a minor decline. JOSB was up six days in a row so it was due for a little pull back. I wouldn't be surprised to see another decline tomorrow. If the market sell-off gets bad look for support near $50.00.

Earlier Comments:
Further gains could spark a short squeeze.
The most recent data listed short interest at 19.8% of the 27.5 million-share float.

Comments:
02/15 update:
Hmm... is this a short-term top in KBH? The housing market index, an assessment of builder confidence, rose for its fifth month in a row this February. Analyst thought this confidence index would rise from 25 to 26 but February's reading saw a jump to 29. This news helped push shares of KBH to a new multi-month high at $12.91 but the gains didn't last. KBH closed virtually unchanged on the session but it still looks like a short-term top.

Readers will want to seriously consider an early exit right now to lock in gains. I would not be surprised to see a dip back toward the simple 10-dma near $11.35. I am not suggesting new positions at this time.

Earlier Comments:
A breakout higher could produced another short squeeze. The most recent data listed short interest at 41% of the 65 million-share float.
Bear in mind that KBH can be a volatile stock. Readers may want to keep their position size small. Our exit target is $13.50.
FYI: The Point & Figure chart for KBH is bullish with a long-term $20.00 target.

Comments:
02/15 update:
ZUMZ rallied to new four-week highs this morning before reversing lower and closing down -2.0%. Look for a bounce near $30.00 or its 50-dma near $29.30 before considering new bullish positions.

It was our plan to exit our February calls at the closing bell tonight.

Earlier Comments:
I am setting two different targets. Conservative traders can exit at $32.25. More aggressive traders can exit at $34.50.